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Friday, July 5, 2013

Karsan Value Funds: 2013 Q2 Results

Karsan Value Funds (KVF) is a value-oriented fund, as described here. Due to securities regulations, the fund is not open to the public at this time. Should that change in the future, there will be an announcement on this site

For the second quarter ended June 30th, 2013, KVF earned $1.64 per share, increasing the value of each share to $15.72. This was an excellent quarter both in absolute and relative terms, as KVF handily outpaced the declining Canadian market and the low single-digit gains of the S&P 500 over the same period.

Contributing to the fund's recent gains were strong returns from GameStop, Ridley, Cisco, Manhattan Bridge Capital and Microsoft (discussed here, here, here, here and here, respectively). As a result of the changes in prices of these companies, the fund no longer holds positions in any of these firms.

Currency gains also contributed meaningfully to results. Had the CAD/USD exchange rate finished the quarter at the same level at which it started the quarter, earnings per share would have been lower by 44 cents. Currency effects are likely to continue to play a significant role in short-term (e.g. quarterly) periods, but are unlikely to be a material factor in the long-term.

Many of the fund's positions have appreciated significantly over the past three quarters, while new opportunities for investment have not presented themselves at the same rate. At the same time, your portfolio manager is likely to be buoyed by overconfidence thanks to strong recent results. All of these factors can contribute to a lowering of standards (i.e. margins of safety) within the portfolio.

While I am not immune to these biases, I am cognizant of them, which is the first step towards ensuring the standards of the portfolio are maintained. Further steps include spending a lot of time turning over rocks and a willingness to question the validity of negative sentiment, in order to find the deepest value opportunities out there.

The good news for investors is that a great deal of my personal net worth is in this fund, so our interests are aligned in ensuring that preservation of capital is not sacrificed in exchange for chasing poor risk-adjusted returns.

KVF's income statement and balance sheet are included below (click to enlarge). Note that securities are marked to market value, and amounts are in thousands of $CAD (except share and per-share amounts):

6 comments:

The one thing I admire most about your blogs is your candor and transparency about failure - as evidenced by your election to dedicate an entire section of your blog to the subject. But after four years of tracking your fund, I find myself compelled to make this comment. I hope you will post this comment because I really appreciate your blog.

A $10,000 investment with your fund at its inception, over four years ago, would have been worth $15,720 at the end of last quarter (June 30, 2013). Ignoring inflation, that is a 12% return annualized. By contrast, the same money invested in a boring S&P 500 index fund would today be worth $19,187 (dividends reinvested) - a 17.6% return. (Source http://dqydj.net/sp-500-return-calculator/)

Lagging the index by over 5.6% over a period of 4 years is something worth paying attention to. Your common refrain, when readers have pushed you on this subject, has been deflective - "need longer sampling period through bull and bear markets."

I think four years is way too long for a sampling period. To put things in perspective, Warren Buffett himself stated in an early partnership letter, almost 50 years ago, that the DOW is a great yardstick standard to which investment performance should be compared on *AT LEAST A THREE-YEAR BASIS.* (Source: Page 4 of http://www.rbcpa.com/WEB_letters/1964.07.08.pdf).

Buffett continued, "All investment managements should be subjected to objective tests . . . the standards should be selected a priori than conveniently chosen retrospectively . . . We started out with a 36-inch yardstick and we'll keep it that way. If we don't measure up, we won't change yardsticks . . . The entire field of investment management, involving hundreds of billions of dollars, would be more satisfactorily conducted if everyone had a good yardstick for measurement of ability and sensibly applied it."

This is what concerns me the most. Retail investors are doing themselves a disservice by making brokerage companies like Scottrade and E-Trade rich. They're also making bloggers like you a little bit of petty cash with ridiculous advertisements, newsletters, and the like. A "-5.6%" relative underperformance, heck a -2% relative underperformance, over an investing lifetime - can mean a world of a difference in absolute dollar terms.

Many of your blogs have been interesting and fun. And many have discussed stocks which have gone on to appreciate. While this may be good or bad (my guess is - in the aggregate - it is bad by several percentage points for all the readers because they're tempted to make their broker rich instead of invest everything in SPY), the single best service you could provide them moving forward is full disclosure about your relative performance.

With such disclosure, the retail investors who waste time surfing "value" blogs will discover that even someone with an MBA who has dedicated years of his life to one task can lag the index after four years. That revelation, which will hopefully induce folks to switch to the S&P 500, will make them insanely more money 30-40 years from now than dancing in and out of "IGOI" and "penny stock debentures."

Thanks for your comment. Assuming you are sincerely seeking a rational discussion on the subject, you raise a number of interesting points.

However, there are enough half-truths and misleading bits of information in your post that I suspect you have already made up your mind on the subject, and therefore a discussion may be useless. I will assume the former, however, and so hopefully you can benefit from my response.

First, the comparison between KVF’s returns and that of the S&P 500 omits some important info. KVF reports in Canadian dollars, the strength of which (since inception) has served to significantly reduce returns. Being based in Canada, KVF also uses an operating structure with which you may not be familiar, but as you can see from the quarterly financials, KVF pays taxes! Yet you are making comparisons to an untaxed S&P 500!

Since KVF’s investors are Canadian, I’m Canadian, and KVF is based in Canada, you have probably noticed the fund’s investments have a rather strong Canadian bias. The Canadian market (as measured by the S&P/TSX) since KVF’s inception, however, is only up some 7% per year.

When you factor in the above, you may find that KVF has *outperformed* the market since inception!

But you won’t find me trumpeting any outperformance to date, which brings me to the second part of the discussion.

First, there is a sample size issue. In investing, luck plays a massive role in the short-term. (How else do you explain a top investor like Warren Buffett getting outperformed by the market in consecutive years?)

You do not want to be making decisions based on just a few years of info, and you definitely don’t want to be extrapolating, as you did, return differences gleaned from a few years of data.

Second, value investing is about generating risk-adjusted returns. Anyone can (and does) generate returns in a bull market. But when the economy goes bad, companies that are high flyers during bull markets can get wiped out. That’s why you want to judge a manager over cycles, not just over a bull market. (Remember that the tech and housing bubbles lasted many years, and investors in those sectors looked like geniuses to some at the time. There were headlines about how Buffett has lost it etc. Don’t think like those guys!)

The S&P 500 is up in the low-single digits since its 2007 (which therefore includes 1 bull and 1 bear market) and 2000 (which includes 2 bull and 2 bear markets) highs, and yet you will find a lot of value managers are up substantially more over this period, because it takes time and cycles for their superior risk accounting to show itself. But don’t take my word for it, as Buffett has stated something like this every year in his annual report (this one from the 2012 letter):

“Our relative performance, however, is almost certain to be better when the market is down or flat. In years when the market is particularly strong, expect us to fall short. “

So even if it turns out that I can’t outperform the market over the long-term, which is perfectly plausible, I certainly wouldn’t suggest that retail investors index. If one has the interest and demeanor, I believe one can outperform the market; and if one doesn’t have the interest or demeanor, I believe one can still outperform by investing with someone who does. But you've got to be willing to have a long-term approach, or you will be fooled by randomness.

Saj, I am not sure what you mean by "factoring the above you may find that KVF has outperformed....." How do you factor in taxes? are you saying if you take your fund's equity and add to it the total taxes it would beat the S&P 500 return?

I agree it is difficult to compare a fund in canada with the tsx index or s&p index and factoring in taxes.

At the same time I am guessing you would lag a S&P 500 index fund in canadian dollars even if you are a real investor that paid taxes on the fund.

But it is all moot because performance must be measured over at least a bull/bear cycle. Anyway can be a genius in a bull market.

I think the fact that you allowed this very critical comment to be posted on your website speaks volumes about you. You are clearly a very honest person with high ethical standards, and I for one consider those attributes to be extremely important.

I think your points about the impact of the CAD/USD exchange rate, the relevance of the S&P/TSX, and measuring performance over the full bull/bear cycle are relevant. But why not let readers know how your performance compares to various indices on an apples-to-apples comparison? For example, you could compare your pre-tax returns to the S&P 500 priced in CAD (or the S&P/TSX). If your fund is now 4 years old, that does seem like a long enough time to start measuring performance.

I do think your point about measuring over the full bull/bear cycle is important, so even if you've lagged the indices on an apples-to-apples basis that's not necessarily the end of the world since there hasn't been a bear market yet.